With recent changes to the tax code, some of the strategies of the past have become outdated, whereas new possibilities have become available. With inflation at the highest it has been in four decades, the need for physicians to utilize these strategies has gained outsized importance.
Editor's note: The information is this story was taken from a recent Medical Economics Bootcamp session. You can find the full video of the session here.
Taxes are inevitable, but that’s no reason they must unduly lighten your bank account. Proper tax planning can keep Uncle Sam from taking an outsized portion of your income. With recent changes to the tax code, some of the strategies of the past have become outdated, whereas new possibilities have become available. With inflation at the highest it has been in four decades, the need for physicians to utilize these strategies has gained outsized importance.
MEET THE PANELIST
David Auer, CPA, MS, PFS, CGMA
President and Founder, Physician Tax Solutions
Planning for your 2022 taxes
The first part of developing an effective tax strategy is finding out which tax bracket you fall into and how much more you can earn before you move up to the next bracket. Most doctors will find themselves paying around 35% and possibly up to 37%, according to David Auer, CPA, MS, PFS, CGMA, president and founder of Physician Tax Solutions. If you have a C-corporation, the tax is a flat 21%, whereas self-employed physicians have a 12.4% and employed physicians have a 6.2% Social Security tax. Physicians should also factor in their capital gains taxes, as well as state income and corporate tax liability.
President Joe Biden has proposed increasing taxes, but legislators are running out of time to make the changes into law before the end of this year. Auer doesn’t believe taxes on the highest earners will rise to the historical high of 94%. “Depending on what state you live in and what other taxes you might be subject to, (your tax rate) could very well be into the 60% to 70% range, and that becomes very important when it comes to tax planning,” he said.
Auer recommends that doctors maximize their retirement plan contributions, which lowers their taxable income and moves them to a lower tax bracket. He also recommends considering a Roth conversion, which involves rolling over transferring funds from a traditional IRA or plan funds to a Roth IRA. This maneuver can be done by individuals who own a traditional IRA, a SEP IRA or those who’ve had a SIMPLE IRA for at least two years. It is also available to those with a 401(k), 403(b) or a government 457(b) plan eligible for distribution.
Roth IRA funds can be withdrawn tax-free so long as the funds have been held for at least five years and the holder is 59.5 years or older. There is also no lifetime required minimum distributions for Roth IRA owners.
Auer also recommends considering funding a “back door” Roth IRA and a Mega Roth 401(k) to further lower your taxable income. If properly utilized, these can enable physicians to put away an additional $66,000 and lower their taxable income.
When it comes to investments, Auer recommends harvesting capital losses, which can offset current and future capital, plus an addition $3,000 a year. However, beware of the capital wash rules that say you can’t buy the same assets, which leads to the initial loss for 30 days.
Physicians should also consider converting W-2 income to 1099 income either in part or entirety. This is helpful, especially if the physician has locum tenens income in addition to their regular job. This also adds the ability to claim business expenses as deductibles.
To those physicians who already have Schedule C/1099 income, Auer recommends considering converting that income to an S-Corporation LLC. This will lower self-employment taxes and reduce the risk of an audit. “Based on the most recent published statistics the IRS has provided, generally speaking, if you have a Schedule C income of over $250,000, you currently have about a 2.5% chance of an IRS audit,” he said. “If you have that same income going through an S-Corporation, statistically, that drops your audit risk down to 0.7% — a fairly significant drop in the risk of an audit, everything else being the same.”
With an S-Corporation in place, Auer recommends considering employing family members by putting them on the payroll and assigning responsibilities. This shifts income from being subject to your tax bracket to being subject to their tax bracket.
A physician can also maximize their home office and automobile deductions. There are acceptable ways to do this, so it’s best to work with a tax planner to ensure you’re getting the most out of your vehicle and workspace. Physicians should also consider the per diem allowances for lodging and meals as opposed to the actual expenses.
Finally, physicians should consider making a pass-through entity (PTE), such as an S-Corporation or partnership, to pay individual state income taxes at the PTE level. You would be able to deduct the cost of that tax dollar for dollar. This is available in 40 states.